The Collapse of Demand! The Case of China

We know, or at least think we do, that world demand is ‘collapsing’. We’ve seen emerging power currencies fall significantly; equity markets deflate; and governments planning and then announcing fiscal stimulus packages. But assessing the state of the BRICSAM economies is not easy. None is more difficult to gauge than China. It remains a rather daunting task to get a handle on the growth/lack of growth of the Chinese economy.

When I was last in China in December, it was impossible to get a ‘read’ on where growth was; or was going. Could one identify growing domestic demand in China? Was this domestic demand beginning to sop up the ‘over capacity’ of China’s export driven economy. Though the government is not being particularly forthright, I’d look to folks like Michael Pettis to provide a picture of the current course of China’s economy. Michael teaches finance at Peking University’s Guanghua School of Management and manages a blog (identified on the right navigation bar at RisingBRICSAM) - China Financial Markets. Michael has apparently worked for many years on Wall Street for various IBs (now mostly departed) and seems to have focused in those days primarily on Latin America.

So is there significant China growth and how have the Government’s policy measures encouraged, or not, domestic demand? Why, relates to an analysis that Michael has related over the past few weeks on his blog posts. First, there is Michael’s examination of how China needs to adjust to avoid a major economic implosion. Besides the blog, you can find Michael’s analysis in the most recent (January/February) Far Eastern EconomicReview (unfortunately the online FEER.com appears to be by subscription only) - the article is entitled “China’s Great Demand Challenge.”

The essence of Michael’s argument is that China stands today in something of the same place, and with the same impact, as the United States held in the global economy in the period prior to and in the Great Depression. China, like the US was back in the 20s, is a huge exporter with significant industrial overcapacity and a large current account surplus. Michael suggests - pessimistically - that US policy then (and potentially China’s policy today) accounted for the severity of the economic collapse and the sustained economic depression of the 30s. In the US case, the country had serious industrial overcapacity that it failed to adjust; further the US failed to expand enough fiscally to compensate for the severe domestic and foreign decline in demand; and the US found itself with a severe monetary contraction - the collapse of banks and a sharp contraction of lending. Authorities in the US case failed to loosen monetary policy swiftly enough, or adequately to counteract the monetary contraction in the collapse of financial institutions.

As Michael summarizes about that earlier global economic crisis, “But as the US continued investing in and increasing capacity, without increasing domestic demand quickly enough, it was inevitable that something had to adjust.” With that scenario in mind, Michael suggests that either China has to increase domestic consumption dramatically, or it has to cut back domestic production. The worrisome conclusion for Michael is that it appears policy makers in China and export-driven states elsewhere in Asia are moving in the US direction of the 1920’s - attempting in particular to defend “its ability to export overcapacity.” As for Chinese fiscal stimulus, he concludes that the Government efforts have been “too feeble to matter much.” Demand creation is not happening in the trade-surplus economies including China. For Pettis the answer to the current global imbalances are a coordinated fiscal response - trade deficit countries like the US should expand moderately to reduce the time of adjustment; and the trade surplus countries must stimulate domestic demand. In China’s case, and given the relative difficulty of stimulating domestic demand (the structure of China’s economy is largely export-targeted), and given the size of the surplus to its GDP, China must be given 3 or 4 years to achieve success.

This leads to an examination of current trade and economic growth trends. In a number of earlier posts - ”Is the US trade deficit sustainable? Is China’s trade surplus?;” and, “As deficit countries contract, Can surplus countries be far behind,” - Michael provides some data that suggest growing trouble. December trade figures identify that exports are off 2.8 per cent, imports are off 21.3 per cent from a year ago. It appears that Chinese consumption is dropping rapidly. Chinese business confidence, measured by the business confidence index, has plunged, falling to a level not seen since 2001. In the same January/February FEER issue, Stephen Green, who runs China research for Standard China Bank in Shanghai, in an article (”Lies, Damned Lies and Chinese Statistics,” pages 14-18), after a lengthy review of the available data suggests that the Chinese economy will grow 6.8 per cent in 2009 and then reach 8 per cent in 2010.

Well, China seems to be still growing. Good news, no. Well possibly, no. The Chinese data suggest: first implicitly that narrow decline in Chinese exports suggests that China continues to press the export button. Further there is little to suggest that Chinese domestic consumption is ‘gearing up.’ Chinese domestic consumption remains a serious problem in an economy where a seamless transition from exports to domestic production is unlikely. Indeed the government’s decision in November to begin offering partial rebates of value-added taxes for thousands of goods produced for export only add to the sense that China will resist cutting back on export production. As Michael was quoted recently in Businessweek (January 12, 2009),”So far, China is acting like it thinks it can export its way out of the problem. I am very, very worried.”

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

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